Kitces: Will model marketplaces redeem robos?
The turnkey asset management platform has been a popular solution for advisers wishing to focus on planning and client-facing duties rather than the actual investment management process and its implementation. The TAMP marketplace today is estimated to be more than $250 billion of AUM.
However, the growing capabilities of automation tools have challenged the TAMP model — and given rise to a new entity, the model marketplace: a grouping of third-party tools explicitly built to handle the trading, rebalancing and overall management of investment models.
But where robos have commonly been viewed with hostility by the adviser trade, the rise of the model marketplace may empower advisers with heretofore unknown choices — namely, whether to outsource just the creation of investment models, or their back-office implementation as well.
History of the TAMP
At its core, a TAMP offers a combination of back-office support for an adviser and third-party asset management for his/her client portfolios.
The TAMP movement first emerged in the 1980s, as the deregulation of fixed trading commissions in 1975 collapsed the traditional stockbroker business model and advisers began the transition from selling stocks to selling investment managers instead. While the bulk of that shift went to the rise of the mutual fund complex — as advisers sold the leading mutual funds and their managers — many who operated in a fee-based environment adopted TAMP solutions.
The appeal of the TAMP — whether adopted as a managed mutual fund (or later an ETF) wrap account, or a separately managed account (or later a unified managed) holding individual stocks and bonds — was the opportunity to have a third-party investment manager set the investment models and implement the investment trades, but without a requirement for the client’s assets to be pooled with others in the form of a mutual fund.
Instead, client accounts and the underlying assets were owned individually and directly by the client, and the third-party investment manager simply had discretion to execute the trades necessary to implement the agreed-upon investment strategy in the client’s accounts. From the adviser’s perspective, it was feasible to provide clients with an individually held, professionally managed investment account, but without the advisers themselves having to create the investment process and staff their own back office.
To leverage the necessary operational efficiencies to execute common investment strategies across a large volume of individual client accounts and advisers, TAMPs quickly became a combination of back-office staffing and technology to support the process. This support ranged from account opening and transfers, to trading and rebalancing, billing and fee sweeps, performance reporting and compliance, along with the investment management solution itself — whether managed directly or by providing vetting and due diligence on third-party managers for which the TAMP is an intermediary.
In some cases, the TAMP functions entirely as a standalone platform and custodian, while in other cases it ties into or overlays existing brokerage or RIA custodian platforms. Early players that are still around today include PMC (now part of Envestnet), Brinker Capital, AssetMark, Lockwood, Loring Ward and SEI, and the TAMP space in the aggregate is estimated at about $250 billion of assets under management.
ROBOS AND MARKETPLACES
In recent years, we’ve witnessed the rise of the robo adviser, which threatened to replace human advisers with automation tools that facilitated the implementation of a usually passive strategic asset-allocated diversified portfolio, matched to the client’s particular goals and time horizon.
In reality, though, robo advisers have struggled to gain market share, and have seen their growth rates lag in recent years due to a struggle to attract assets and actually gain market share with the technology they’d built. This is owed to the hyper-competitive marketplace for asset management and the incredibly high client acquisition costs it entails.
In other words, robo advisers created an efficient operational solution — digital onboarding, automated trading, rebalancing tools to manage model portfolios — to what is ultimately a distribution problem: how to get your particular managed account solution into the hands of consumers.
But that doesn’t mean the robo technology itself — as a tool that automates both onboarding, and more importantly the trading, rebalancing and management of models — isn’t valuable. For instance, several years ago I wrote:
“Robo adviser software as a trading tool creates the potential for investors and/or their advisers to implement and self-automate their own tilts, filters, screens, trading algorithms and rules-based investment strategies. Popular strategies … could be licensed directly through the platform, allowing any investor to have access to the strategy of an investment manager, implemented automatically on their behalf. Or alternatively, investors or their advisers could create any number of their own investment strategies as well, and then allow the software to automate their implementation.”
And in just the past few months, this exact prediction has begun to play out.
First came the TD Ameritrade National LINC conference, with the RIA custodian announcing the creation of its new iRebal Model Market Center, where advisers can directly access third-party investment management strategies by having their models uploaded directly into the iRebal trading software for the adviser to implement themselves. Then, at the Technology Tools for Today (T3) Advisor Technology Conference in February, Riskalyze announced that its Autopilot platform was launching a partner store that would allow advisers to use its new trading and rebalancing tools to directly implement the models from a series of third-party investment managers.
Advisers, get ready to track — and secure — client information streaming in from physical properties and a vast array of accounts.
And then at the same conference, Orion Advisor Services announced the launch of Eclipse, which embedded in its own version of a newly launched trading and rebalancing software platform will include so-called Eclipse Communities, where advisers can share their investment models for implementation with other advisers in a kind of peer-to-peer model marketplace.
To recap: In the span of barely a month, three major platforms have announced the rollout of a model marketplace where advisers can use robo trading and rebalancing automation tools to implement third-party–managed models, without the need to fully delegate to a TAMP.
Rather, instead of using the TAMP, the adviser can simply use the robo software to implement all of the models and trade signals directly from the investment manager themselves, using the adviser’s existing investment platform.
DELEGATION VS. AUTOMATION
As noted earlier, a TAMP ultimately bundles together two core functions: providing a third-party investment management strategy — i.e., portfolio models — and implementing it via the back-office trading and other tasks to support the investment implementation process. From this perspective, the emergence of model marketplaces effectively represents the unbundling of the traditional TAMP.
In essence, the opportunity of a model marketplace is to distribute third-party investment management strategies, via their model portfolios, to advisers for the advisers to implement themselves. Thus, the adviser can get access to outside managers and their models without fully delegating the portfolio management role and the associated discretion. Instead, the manager sends the model and any trade updates to the marketplace, and the adviser implements it themselves. The key distinction? With modern trading and rebalancing software, the implementation itself becomes largely automated.
Of course, that still requires the adviser to retain responsibility for configuring and implementing the trading and rebalancing software itself. Client accounts still have to be onboarded by the adviser, loaded into the rebalancing software and assigned to the model. And the adviser still must — or at least, should want to — review the suggested model trades when the model changes, and hit the button to authorize the model trades in client accounts that the software queues up.
Nonetheless, model marketplace fundamentally change the decision-making process about using a TAMP. Now, it’s no longer a question of creating and managing your own investment process and implementing it, or delegating it all to a TAMP. Instead, for those who want access to outside managers, it’s now simply a question of whether you want to retain control to implement the third-party investment models yourself — the so-called rep as portfolio manager approach — or delegate to someone else to handle the trades and other back-office work of those third-party models, too, with a full TAMP solution.
In other words, it’s no longer a decision of fully retaining control versus fully delegating the process of investment model building and implementation. The model marketplace introduces a hybrid option: to select from third-party investment models, but retain control about whether/how to implement them, while using technology to ensure that implementation isn’t onerous.
Notably, the rise of the model marketplace isn’t solely a function of robo-rebalancing and model management technology tools making implementation feasible. It’s also being driven by asset managers themselves, who are seeking new ways to drive distribution into increasingly commoditized ETF and index fund products that aren’t themselves very differentiated, and to generate additional revenue given the competitive cost-cutting happening to the underlying investment products themselves.
In other words, asset managers are struggling to gain market share and make money on the underlying investment products themselves, and instead are looking at model management as an opportunity for both fund distribution and a new layer of management fees.
This business model was also indirectly validated by the robo movement, as the rapid growth of Schwab Intelligent Portfolios — using a preponderance of Schwab ETFs — demonstrated that it’s feasible to distribute managed models of otherwise largely commoditized ETFs as a way to grow market share and revenue.
Of course, Schwab itself has offered its managed account service for free because its underlying ETFs are still profitable, but the validation that robo-managed accounts can help to distribute ETF products — and the potential to charge for the ETF strategies they manage — helped drive robo M&A, including Blackrock and iShares ETFs’ acquisition of FutureAdvisor, the Invesco (which also owns PowerShares ETFs) acquisition of Jemstep and WisdomTree ETFs’ investing in AdvisorEngine.
In other words, as expense ratios on so many ETFs crash down to just basis points in the low single digits, the potential to sell managed models of those ETFs for a managed account fee of 10bps, 20bps or 30bps represents a substantial revenue expansion opportunity.
Managed models that are well-diversified — i.e., not all in a <5 basis point S&P 500 Index fund — also create the potential for asset managers to allocate at least a portion of client funds to less-commoditized and therefore higher-cost and higher-revenue-generating funds in their lineup that can generate more revenue.
As a result, it’s no coincidence that TD Ameritrade announced that its initial models would be provided by a series of asset managers — likely to be comprised predominantly of ETF providers who will construct portfolios of their own ETFs and either charge a management fee or generate more expense-ratio revenue by allocating across a range of their ETFs with varying expense ratios.
Ultimately, though, the opportunity isn’t unique to just asset managers that produce investment products. Model marketplace create opportunities for any investment manager to distribute their investment strategies, including asset managers, specialized investment managers and even other advisers.
Because now, those who want to gather more assets into their investment strategies won’t need to build their own TAMP or outsourcing solution, or try to create their own ETF or mutual fund. Instead, they’ll simply need to get their models into a model marketplace, and then try to get advisers to adopt the solution — without all the back-office hassle.
ENVESTNET AND THE COMPETITION
Notably, the idea of being a platform that connects a wide array of third-party investment managers directly to advisers isn’t new. Indeed, it’s one of the primary ways that Envestnet generates its revenue.
As while most independent RIAs simply know of Envestnet as a provider of adviser technology — including Tamarac CRM and rebalancing software, FinanceLogix planning software and more – Envestnet’s investment solutions, including PMC, its UMA solution and fund strategist network comprise an entire marketplace of third-party investment management for advisers.
However, Envestnet still functions primarily as an intermediary that connects and introduces advisers to various forms of TAMPs — often as SMAs — as well as its own (PMC) managed solutions, but not necessarily as a model marketplace that helps advisers implement those third-party investment solutions themselves. From this perspective, arguably the rise of the model marketplace is also a direct competitive challenge, and alternative solution, to Envestnet itself.
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The question remains, though, as to where it is best to situate a model marketplace It’s notable that the three initial providers so far have all built their model marketplaces into their rebalancing software, as it’s the rebalancing software that’s crucial to facilitate the implementation itself.
However, Riskalyze’s Autopilot Partner Store is part of its robo-adviser-for-advisers solution and an extension of its risk tolerance assessment tools, while Orion Eclipse Communities is part of a portfolio accounting software solution, and the iRebal model marketplace is part of TD Ameritrade’s offering as an RIA custodian. Yet it’s unclear where advisers will actually want to engage. Would it be through their robo tools, portfolio accounting software or directly via their custodian?
Meantime, it seems likely that other rebalancing software competitors will soon create their own competing model marketplaces. Envestnet itself owns Tamarac rebalancing software, and it’s not hard to imagine that it might soon begin to offer its existing third-party manager and strategist network directly as adviser-implemented models through Tamarac, rather than directly just via the managers.
And with last year’s acquisition of Total Rebalance Expert (tRx) software by Morningstar, it wouldn’t be surprising to see Morningstar get into the model marketplace game soon as well, especially since Morningstar already has extensive capabilities for building and distributing investment management strategies and getting paid for investment models.
Perhaps the greatest competitive challenge of the new model marketplace, though, won’t be the competition among the marketplaces, but rather the newfound pressures they place on TAMPs themselves.
After all, according to one recent study, the typical all-in cost of most TAMPs still varies from 0.75% to 1.5%, but it’s hard to imagine advisers and their clients tolerating such fees for just receiving models that they themselves implement, once the back-office implementation no longer falls to the TAMP provider.
Clearly, the value of investment models and their underlying intellectual property is worth something. But once the back-office services are unbundled, the price point will almost certainly be much lower. And it will be up to advisers themselves to decide whether to also outsource the back-office duties and go full TAMP, or simply to leverage the model marketplace and let the trading and rebalancing software make it as easy as possible.
The bottom line, though, is simply to recognize the emergence of model marketplace as a major shift in the landscape of investment management, with respect to both the distribution of both third-party investment managers and the products that asset managers produce. In the process, model marketplaces will threaten both existing marketplace incumbents like Envestnet, and the current paradigm of third-party TAMPs.
That doesn’t necessarily mean the existing solutions will go away altogether. Indeed, Envestnet still brings other capabilities to the table, and some advisers — particularly smaller independents with limited staff resources — will still want to rely on full TAMPs to fully delegate their investment process and its implementation. Nonetheless, the rise of the model marketplace appears to represent one of the true disruptive threats of robo adviser technology finally coming to bear.